Tax Relief On Pension Contributions

Simon Misiewicz

Expat & Property Tax Specialist

29th January 2016

What is a pension anyway?

A pension, in short, is a pension scheme or arrangement whereby it provides benefits in one or more of the below circumstances:

– retirement

– death

– having reached a particular age

– serious ill-health or incapacity, or

– similar circumstances.

Types of pension benefits

The pensions tax legislation categorises the type of benefits a pension scheme will provide into the following four types of pension benefits:

Defined benefit – these schemes should provide a set amount of benefit, where the amount of benefit does not depend on how much money is within the scheme. Final salary and career average schemes are examples of defined benefit schemes.

Money purchase – also known as defined contribution. The amount of pension is not known in advance. It will depend on how much money is in the scheme. The size of the member’s pension pot in the scheme will depend on the contributions made.

Cash balance – these are a type of money purchase scheme. For the purposes of providing member benefits, the rules are the same as for money purchase/defined contribution benefits. The difference between pure money purchase and the cash balance is that the size of the member’s pension pot isn’t only dependent on the contributions that have been paid to the scheme.

Hybrid – these schemes may provide either defined benefit, money purchase or cash balance benefits. Only when benefits are drawn will the form of the benefit be set.

Types of pensions — employee contributions

An employer pension scheme is often referred to as an occupational pension scheme. It may provide benefits as outlined above for its employees under Section 150(5) of the Finance Act 2004. And Section 30 of the Finance (No 3) Act 2010.

Employees can obtain tax relief on contributions they make from their own earnings into their pension up to a maximum of:

– £3,600 (for those not paying income tax); or

– the entirety of the member’s relevant UK earnings (up to the annual allowance)

While those making pension contributions will benefit from tax relief on their contributions, this is limited to £40,000 per year (pension contributions annual allowances) and there is a lifetime contributions allowance of £1,250,000 (tax year 2014-15).

You can go back two tax years and make pension contributions to utilise your annual allowance. Therefore you could, in effect, make £120,000 of pensions contributions in two years’ time.

A note on salary sacrifice 

If you make pension contributions and are not part of a “salary sacrifice scheme” then you may only receive basic tax relief from the pension scheme. As such you will need to reclaim the additional tax if you are a higher rate or additional rate taxpayer on your self-assessment. You’ll get a statement from your pension provider.  This statement tells you how much tax you owe if you go above your lifetime allowance. Your pension provider will deduct the tax before you start getting your pension.

Types of pensions — employer contributions

Did you know that your employer (also your own business) can pay into a pension on your behalf? Not only can you personally pay into a pension and benefit from a tax relief but your company can to. As an added bonus the pensions contribution that the company makes is also tax allowable.

A new law means that every employer must automatically enrol workers into a workplace pension scheme if they:

– are aged between 22 and State Pension age

– earn more than £10,000 a year

– work in the UK

This is called ‘automatic enrolment’.

Usually, your employer takes the pension contributions from your pay before deducting tax (but not National Insurance contributions). You only pay tax on what’s left. So whether you pay tax at the basic, higher or additional rate you get the full relief straightaway.

If your employer can’t deduct your pension contributions from your pay you can still get tax relief. You’ll need to claim the tax relief you’re due through your tax return, or if you don’t complete a tax return by contacting HM Revenue & Customs (HMRC).

However, some employers use the same method of paying pension contributions that personal pension scheme payers use – read more in the section on ‘Personal pensions’

Many employers have either a company pension scheme that they’ve set up for their employees or provide access to a group personal scheme. Your employer will also contribute towards your pension.
From October 2012 employers had to start enrolling their employees into a pension scheme and pay contributions for them.

Employers may make pension contributions for their employees. There is no limit to the amount of money that the employer may contribute on behalf of an employee. However, care must be taken not to exceed the employee’s annual pension contributions limit. Any excess may be taxable by the employee and have a surprise of nasty tax liability. The annual pension contributions for an employee is currently £40,000.

The employer benefit of making pension contributions over salary payments is the employer’s national insurance savings. In some cases, the employer’s can save 13.8% National Insurance.

Corporation tax treatment of defined benefit pensions contributions 

Employers may reduce their corporation tax liability by the amount of money that they have invested in the pension as it is deemed that employer contributions are an allowable cost.

Sections 307 and 308 of the Income Tax (Earnings and Pensions) Act 2003

The contributions an employer makes to a registered pension scheme on behalf of an employee are exempt from being taxed as earnings for the employee. However, the employer’s contributions will count towards the member’s annual allowance limit. So the member may have to pay tax if the employer contributes too much.

Where the employer is a company with investment business the employer contributions will be deductible as an expense of management (Chapter 2 of Part 16 of the Corporation Tax Act 2009).

Payments made on behalf of directors and shareholders of the company 

Payments made on behalf of the directors/shareholders are considered to be wholly and exclusively for the purposes of the trade. As such these contributions will benefit from corporation tax relief.

If you are part of an employer scheme and you personally make pension contributions, you are entering into a salary sacrifice arrangement whereby you get tax relief at source on pension contributions in each and every pay packet, be it weekly or monthly.

Are all the employer's contributions towards a personal pension allowable

Payments made to employee’s pensions

As shown in the S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009 that pension contributions are allowable. This is provided that the employer pension contributions is to an employee or director of the company. Any payments made to the employee’s pension contribution will be seen as Wholly Exclusive and Necessary. HMRC will look at the case where pension contributions seem excessive to the salary provided to the employee. HMRC may take a dim view where the employee is paid £10,000 as salary but £40,000.

Any payments made from the employer to the employee’s pension contributions in a winding-up situation will not be allowed. As HMRC’s website shows. There was a court case CIR v Anglo Brewing Co Ltd [1925] 12 TC 803 that has significance. In this court case, it was shown that payments to a going concern are allowed but not one that is in a winding up situation.

An employer cannot make excessive employer contributions to the market value the person would receive for the same job elsewhere.

Employer pension contributions made to directors and shareholders

The relevant piece of legislation on this point is the S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009. Any payments made to the directors and shareholders of a company are allowable provided it meets the Wholly Exclusive and Necessary tests. HMRC’s website shows that employer pension contributions will not be allowed if the person in question is not involved in the business. Examples are relatives of the directors or shareholders.

Pension contributions limited to £10,000

Whilst the above was a very nice way to invest and get tax relief, the government have decided to stop people benefitting from the tax relief by investing in their future, as can be seen from their website.

The amount of money that you can invest in a pension now drops from £40,000 for every £2 you earn over £150,000. If you earn £160,000, then this is £10,000 over the £150,000 rate.

This means that the pension contribution allowance is reduced by £5,000.

This person could now contribute £35,000 into their pension and get tax relief on it.

If you earn more than £210,000, then the maximum amount of money that you can invest in a pension is limited to £10,000. Our specialist tax advisers can assist you further in discussing your wealth planning.

Practical steps you should now take to make the most of your pension

– Set up a registered pension (scheme administrator) through an agent or IFA, making sure they have permission from the Financial Conduct Authority (FCA)

– HMRC will then consider the pension registration and inform the employer/scheme administrator of their decision on whether to allow registration or not

– HMRC will provide a registration date of the pension

If you want to know more then please read our “buy to let tax tips for UK landlordsarticle

Pitfalls of pension contributions 

It is possible that an employer may have made £40,000 pension contributions on the behalf of the employee. However, without both the employee or employer knowing that the level of contributions has exceeded the annual allowances. In this case, we will assume that the employee is a high rate taxpayer. The £10,000 excess will then have a £4,000 (40%) tax charge.

It can get much worse, without the right tax advice and wealth planning professional inputs. Let’s assume that an employee draws down some of his pension to get 25% tax relief and starts to take the pension benefits annually. This would reduce their pension contribution annual allowances from £40,000 to £10,000 based on the governments’ website known as Money Purchase Annual Allowance (MPAA).

If we now look back and see that the £40,000 pension contributions exceed the £10,000 by £30,000. As such, the employee will then have to pay a tax of £12,000 (£30,000 x 40%).

You need to be mindful of:

– What your annual allowances are for pension contributions

– Who make the contributions

– Who gets the tax relief

If you are a business owner, it provides additional benefits:

– Gets money out of the limited company in a tax-efficient way

– The above reduces the overall value of the business from an inheritance tax perspective

– You do not need to increase your salary costs to make the pension contributions, which would incur national insurance costs for both the employee and employer

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